What does debt consolidation do to your credit?

Debunking the credit score myth

It’s a commonly held belief that debt consolidation can negatively affect your credit score. That is, you think that by admitting that you’re struggling with debt, creditors will view you less favourably, and your credit score will suffer as a result. But is this actually the case?

Thankfully, this is nothing more than a financial myth. Debt consolidation is actually a proven and effective method for dealing with your debts and improving your credit score in the process.

How does this work, exactly? A debt consolidation loan doesn’t just remove the stresses that many New Zealanders just like you face when struggling to stay on top of their debts. It also improves your credit report, by showing that you’ve cured any defaults, payed off your creditors, and are working towards a more positive, financially stable future. Your credit score then improves as a result, which is just one of the many benefits of consolidating your debts.

In comparison, other debt solutions such as debt management or debt settlement attempt to forgive or reduce your debt, which can negatively impact your credit score as a result. Not only do these methods carry numerous risks - with no guarantee of success - but your credit score will also take a hit as it’s recorded in your report that you were late or skipped payments, or didn’t pay off your debts in full.

While a debt consolidation loan can often appear as a new line of credit in your report, the positive effects of paying off two, three, four or more of your debts far outweighs any negatives associated with a new line of credit.

An example of debt consolidation and how it affects your credit

Name: James

Age: 33

Occupation: Store manager

Scenario: Consider James. He’s a 33 year old store manager from Hastings. He’s married, with two kids, and earns what many would consider to be a decent income. He’s also currently behind on his car loan repayments, he’s defaulted on a personal loan, and his credit cards are maxed.

While James would love nothing more than to rid himself of these debts, each and every one of them is currently recorded in his credit report, which negatively impacts his credit score.

How did consolidating debt help James’ credit score?

By taking out a debt consolidation loan, James was able to pay off all of his outstanding debts and cut up his credit cards. As a result, all of these are now marked as paid in full on his credit report.

When a creditor now looks at James’ credit report, they see that he’s paid down his debts, and that he’s taking the required action to ensure these are dealt with: James is taking responsibility for his debts, and he’s seen as more financially reliable as a result.

By continuing to meet the payments of his new debt consolidation loan, James’ credit score will only continue to improve, as he’s showing creditors that he can meet the financial demands that this loan places on him.

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